The United States of Inequality

The National Bureau of Economic Research is a nonprofit and rigorously nonpartisan think tank best known today as the place where a committee of economists makes the official call about when recessions begin and end. But it owes its existence to a friendly dispute that arose in 1916 between a conservative named Malcolm Rorty, who worked as a statistician for the American Telegraph and Telephone Company, and a liberal economist named Nahum Stone, who worked as a labor arbitrator. The topic was the distribution of income in the United States.

Stone had written about income distribution for a socialist monthly, and Rorty, who disagreed with Stone's conclusions but admired the quality of his scholarship, invited him to lunch. "Would it not be a great step forward," Rorty proposed, "if we had an organization that devoted itself to fact finding on controversial economic subjects of great public interest?" Funds were secured from the Carnegie Corporation and the Commonwealth Fund, and an Episcopal seminary set aside office space in Lower Manhattan. When the National Bureau of Economic Research opened its doors in 1920, its first project became a two-volume survey of the distribution of income in the United States. One of the study's authors was our old friend Willford I. King (see Part 1).

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Today the NBER is headquartered not in New York but in Cambridge, Mass., in a glass-and-concrete midrise along Massachusetts Avenue, the street that connects Harvard to the Massachusetts Institute of Technology. The NBER draws heavily on the economics faculties of both universities. I paid a visit there to ask Harvard's Lawrence Katz and Claudia Goldin about their theory of income inequality.

Computerization eliminated many moderately skilled jobs, and it increased demand for workers with a college or graduate-level education. But for various reasons cited in Part 4 of this series, computers don't seem by themselves to be a major cause of the Great Divergence. Katz and Goldin argue in their 2008 book, The Race Between Education and Technology, that lots of other technological advances throughout the 20th century created comparable (sometimes greater) demand for a better-educated labor force. Yet these earlier changes didn't typically generate income inequality. Why was the advent of computers different?

For Katz and Goldin, the solution to this riddle isn't that computerization created a larger demand for better-educated workers than did previous innovations. Rather, it's that during the earlier upheavals the education system was able to increase the necessary supply of better-educated workers. During the Great Divergence, the education system has not been able to increase the supply of better-educated workers, and so the price of those workers (i.e., their incomes) has risen faster relative to the general population. At a time when the workforce needed to be smarter, Americans got dumber. Or rather: Americans got smarter at a much slower rate than they did during previous periods of technological change (and also at a much slower rate than people in many other industrialized democracies did). That was great news for people with college diplomas or advanced degrees, whose limited supply bid up their salaries. It was terrible news for everyone else.

If we were to compile a list of the ways in which the United States has made both itself and the wider world a better place, then at or very near the top would be its commitment to universal education. We no longer think of education for all as a particularly novel or controversial goal. But at the start of the 20th century it was both. The first public high school in the United States was established as early as 1821 in Boston, but it wasn't until the early 20th century that high schools spread rapidly outside major cities, and it wasn't until 1933 that the majority of high-school-age kids in the United States actually attended high school. High schools differed from the college preparatory schools that preceded them in two ways. They were government-funded, as college-prep schools only sometimes were (Boston Latin was; New York's Collegiate School wasn't). And they were meant to serve not just teenagers who would go on to college, but also teenagers who would bypass college and enter the workforce at 18.

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Europeans, Katz and Goldin observe, thought that America's egalitarian approach to education was soft-hearted and wasteful. They preferred a system that selected only the most promising adolescents for further schooling, and even then the child's parents usually had to pay for it. As late as the 1930s, Katz and Goldin note, "America was virtually alone in providing universally free and accessible secondary schools." But while Continental sophisticates scoffed, America's better-educated masses became a vital component to its superior performance in a world economy that could no longer easily accommodate anyone whose education stopped at age 12 or 13.

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In the early part of the 20th century, office workers had to know how to operate typewriters and adding machines. They had to master bookkeeping, billing procedures, and stenography. These and other necessary skills were more easily acquired by high-school graduates. The need for high-school-educated employees was not confined, as you might suppose, to the rapidly growing white-collar workforce. Farmers had to master elementary genetics to grow hybrid corn. Factory workers often had to know algebra and geometry, how to read mechanical drawings, and at least the basics of how electricity worked. As early as 1902, the personnel chief at National Cash Register Company in Dayton, Ohio, said, "In the factory we like the boys to have a high school education if possible." The need for ever-more-educated workers persisted to the point that by the century's end, college displaced high school as a threshold requirement. In 1950 only 8 percent of all full-time workers were college graduates. By 2005, about 32 percent were, and an additional 29 percent had some college education.

Throughout the first three-quarters of the 20th century a growing supply of better-educated workers met the demand created by new technologies. The 1944 G.I. Bill, which paid tuition for returning servicemen, played an important role; so did the Sputnik-inspired National Defense Education Act, which increased federal spending on schools at all levels and created (at the suggestion of Milton Friedman!) a student-loan program for colleges. With the passing of each decade, the average 24-year-old had close to one additional year of schooling. These gains virtually halted starting with 1976's cohort of 24-year-olds. Educational attainment started growing again in the 1990s, but at a much slower rate. Here's another way to put it: The average person born in 1945 received two more years of schooling than his parents. The average person born in 1975 received only half a year more of schooling than his parents.

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The abrupt halt and subsequent slowdown of gains in educational attainment began at about the same time as the Great Divergence. Before the Great Divergence, the country enjoyed at least three decades of growing income equality, an epoch that Goldin and Boston University economist Robert Margo have termed "The Great Compression." Between 1900 and the mid-1970s, U.S. incomes became dramatically more equal while educational attainment climbed. But starting in the mid-1970s and continuing to today, incomes became dramatically less equal while educational attainment stagnated. Katz and Goldin believe this is not a coincidence.

Unlike the computerization trend, the slowdown of educational attainment gains is not occurring in all industrialized nations; it is uniquely American. Remember those Europeans who scoffed at the Yanks' misty-eyed commitment to universal education? Around the middle of the 20th century they started to wise up and expand educational opportunities in their own countries. By the end of the century Europe had caught up with or exceeded average educational attainment in the United States. According to the Organization for Economic Cooperation and Development, the United States has proportionally fewer high school graduates (measured as the percentage of young people at the typical graduation age) than Germany, Greece, the United Kingdom, Ireland, and Italy (see Table A2.1)."We have the most-educated 55 year-olds in the world," Katz told me. "But we're in the middle of the pack for 25 year-olds."

The trend was likely kicked off by the end of the Vietnam draft in 1973. College students had received deferments. Until 1968 graduate students received deferments, too. The deferments had the effect of inflating college and grad-school enrollment, already enlarged by the baby boom, thereby lowering the market price for college graduates. From 1970 to 1976 college enrollment increased by 50 percent; it would be three decades before college enrollment increased that much again. In 1976 the Harvard economist Richard B. Freeman published a book titled The Overeducated American that argued the monetary return on a college education—what economists call the "college premium"—had dropped to its lowest level since World War II. But with the Vietnam draft gone and the last of the baby boomers graduating from college, that trend began to reverse itself. It was no longer necessary to enroll in college if you wanted to stay out of Khe Sanh, and fewer kids were reaching college age. As a result, the college premium began to grow. It's been growing ever since. Goldin and Katz calculate that it accounts for two-thirds of the increase in income inequality during the Great Divergence.

Why did the trend continue? Katz and Goldin are somewhat tentative on this point, but clearly it represents a failure by elementary and secondary schools to provide education relevant to the economy's growing demands, a task they performed much better during the first half of the 20th century. Katz and Goldin blame America's colleges and universities, too—not for any educational failing (the United States is a global leader in higher education) but rather for tuition costs, which took off in the 1980s and have accelerated well in excess of general inflation ever since. High school graduates aren't receiving a significantly better education, on average, than their parents did, partly because elementary, middle, and high schools are inadequate, and partly because the cost of a college education is increasingly prohibitive.

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We have now reviewed all possible causes of the Great Divergence—all, at least, that have thus far attracted most experts' attention. What are their relative contributions? Here is a back-of-the-envelope calculation, an admittedly crude composite of my discussions with and reading of the various economists and political scientists cited thus far:

Race and gender are responsible for none of it, and single parenthood is responsible for virtually none of it.

Immigration is responsible for 5 percent.

The imagined uniqueness of computers as a transformative technology is responsible for none of it.

Tax policy is responsible for 5 percent.

The decline of labor is responsible for 20 percent.

Trade is responsible for 10 percent.

Wall Street and corporate boards' pampering of the Stinking Rich is responsible for 30 percent.

Various failures in our education system are responsible for 30 percent.

Most of these factors reflect at least in part things the federal government did or failed to do. Immigration is regulated, at least in theory, by the federal government. Tax policy is determined by the federal government. The decline of labor is in large part the doing of the federal government. Trade levels are regulated by the federal government. Government rules concerning finance and executive compensation help determine the quantity of cash that the Stinking Rich take home. Education is affected by government at the local, state, and (increasingly) federal levels. In a broad sense, then, we all created the Great Divergence, because in a democracy, the government is us.

It seems obvious to me that a decades-long trend toward income inequality is destructive to any nation, and particularly to one founded on democratic ideals. But it isn't obvious to everybody. Some people have questioned whether it's worth fretting about. In the next and final installment, I'll consider their arguments and try to explain why we'll all be better off when the Great Divergence ends—or, better yet, reverses itself.